Regulation A

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Speaking at a session at the American Bar Association’s annual meeting, a representative of the Securities and Exchange Commission’s Division of Corporation Finance (Michael Seaman) provided guidance for attendees regarding areas of focus in the coming months.  After reviewing some of the Commission’s recent rulemaking initiatives, including the Concept Release regarding Rule 701 and Form S-8, the recent changes to Regulation S-K to address outdated, duplicative and other similar rules, and the proposed amendments to the disclosures required by Regulation S-X Rule 3-10 and Rule 3-16, Mr. Seaman commented on ongoing and upcoming priorities.  He noted that the staff is working on proposed rules that would address the statutory change that permits Exchange Act-reporting companies to undertake Regulation A offerings.  There appears to be significant interest on the part of smaller public companies in relying on the exemption.  Mr. Seaman cautioned that the exemption is not available to such companies until the Commission adopts final rules.  He noted that the staff continues its work on proposed changes to Industry Guide 3 for financial services companies.  Guide 3 requirements may be simplified in light of the disclosures required of regulated financial institutions as a result of Basel III and other standards, as well as disclosures otherwise already contained in financial statements and the accompanying notes.  Consistent with remarks made by other Commission representatives, Mr. Seaman noted that the staff also is working on a concept release related to private offering exemptions intended to harmonize conditions for such exemptions.  When asked whether there would be additional rulemaking in furtherance of the Commission’s disclosure-effectiveness initiative, Mr. Seaman noted that the staff continues to review other aspects of the Regulation S-K requirements, including those on which comment was sought in the Concept Release on Business and Financial Disclosure required by Regulation S-K.

As far as areas of staff comment, Mr. Seaman noted that the staff was reviewing issuer disclosure related to cyber breaches and cybersecurity and commenting on risks that were generic and did not address issuer-specific facts and circumstances, as well as on disclosures related to incidents of breaches.  He also noted that the staff was reviewing dispute-resolution provisions in governing documents that may have the effect of limiting investors’ rights, such as provisions requiring mandatory arbitration, waiver of jury trial provisions, provisions related to class-action waivers, and provisions requiring a minimum ownership threshold in order to bring certain claims.  In this regard, the staff was commenting on issuer disclosures related to the inclusion of such provisions in the governing documents with a focus on ensuring that such provisions are clearly explained and investors understand the risks associated with such provisions, including the limitations on remedies, as well as ensuring that issuers are addressing in their disclosures whether such provisions are enforceable and comply with the securities laws.

Mr. Seaman also mentioned a new initiative, led by the Chief Counsel’s office, with the support and involvement of other groups, to review all of the Compliance & Disclosure Interpretations for any required updates, as well as to eliminate any C&DIs that may no longer be relevant or applicable.  He encouraged practitioners to provide their views regarding any C&DIs that may be confusing or problematic, as well as any areas or topics that may be appropriate to address in new C&DIs.

Neal Newman assesses the success of Regulation A in a paper titled, “Regulation A+:  New and Improved after the JOBS Act or a Failed Revival?”  The author reviews the 267 Regulation A filings made between August 13, 2012 and May 24, 2016 and samples a subset of 48 filings from this period.  Of the sample, 19 were Tier 1 filings (39.6 percent) and 29 were Tier 2 filings (60.4 percent).  For the Tier 1 filings in the sample set, the average minimum offering amount was $829,861 and the average maximum amount was $17,677,397.  Average total assets over the sample were $6,215,061.  Based on the Tier 1 offerings in the sample, the author concludes that very few of the filers sought to raise the maximum $20 million permitted under Tier 1 and few of the Tier 1 issuers were of a size to need $20 million in capital.  It took, on average, 375 days to get qualified.  By contrast, for the Tier 2 offerings in the sample set, the average maximum was just over $23 million.  On average, these Tier 2 offerings took 120 days to be qualified.  Based on the author’s assessment, he notes that the only persuasive rationale for relying on Regulation A rather than on Regulation D would be the ability to sell securities to non-accredited investors.  The author supplemented his quantitative analysis with interviews of issuers that undertook Regulation A offerings.  Contrary to the author’s expectations, the companies that undertook Regulation A offerings were pleased with their financing approach despite the ongoing reporting requirements and the time (and expense) associated with the Regulation A offerings.  The author concludes with a cautionary example, citing an early Regulation A issuer that since has failed to achieve profitability.

July 19 – 20, 2018

PLI New York Center
1177 Avenue of the Americas
(2nd Floor)
New York, NY 10036

This program will provide an overview and discussion of the basic aspects of the U.S. federal securities laws by leading in-house and law firm practitioners as well as SEC staff. Emphasis will be placed on the interplay among the Securities Act of 1933, the Securities Exchange Act of 1934, the Sarbanes-Oxley Act, the Dodd-Frank Act, the JOBS Act, the securities related provisions of the FAST Act, related SEC regulations and significant legislative and regulatory changes and proposals.

Partner Anna Pinedo will lead a session titled “Securities Act Exemptions” on Day One of the program. Topics will include:

  • Exempt securities versus exempt transactions;
  • Private placements, including offerings under Rules 504 and 506 of Regulation D;
  • Regulation A+ offerings;
  • “Intrastate” offerings, including new Rule 147A;
  • Crowdfunding;
  • Employee equity awards;
  • Rule 144A offerings;
  • Regulation S offerings to “non-U.S. persons”; and
  • Resales of restricted and controlled securities: Rule 144, Section 4(a)(7) and 4(a)(1½).

PLI will provide CLE credit.

For more information, or to register, please visit the event website.

Wednesday, July 18, 2018
1:00 p.m. – 2:00 p.m. EDT

The new administration began with calls for a repeal of the Dodd-Frank Act and related regulations. Over time, banking agency actions and legislation have brought about more measured regulatory changes. During our session, we will review the changes that have come as a result of actions taken by the banking agencies, including proposed amendments to the Volcker Rule and the proposed stress capital buffer. We will also address the changes contained in the recently enacted Economic Growth, Regulatory Relief, and Consumer Protection Act. We will also provide some perspective on the additional changes that should be expected in the near term.

We will address the following:

  • Overview—outlining changes being made/proposed by banking agencies and legislative changes;
  • Amendments proposed by the agencies to the Volcker Rule;
  • Amendments to the Volcker Rule contained in the Crapo legislation;
  • Changes to the designation of entities subject to the enhanced prudential supervision provisions; and
  • Securities law provisions contained in the Crapo legislation.

Speakers:

  • David R. Sahr
    Partner, Mayer Brown LLP
  • Anna T. Pinedo
    Partner, Mayer Brown LLP

For more information, or to register for this complimentary session, please visit the event website.

In his most recent testimony in Congress, the Securities and Exchange Commission Chair once again focused on retail investors.  Chair Clayton cited a number of statistics regarding the level of retail participation in the capital markets.  He noted that at least 51 percent of U.S. households are invested directly or indirectly in the U.S. capital markets.  Chair Clayton noted that the recently released strategic plan has as a cornerstone a focus on retail investors.  Addressing a frequent theme, Chair Clayton commented on the decline in the number of U.S. public companies.  He also noted the impediments to investment in private companies by “Main Street investors,” which impediments limit Main Street investor participation in the growth of many successful private companies.

Addressing the Commission’s plans, Chair Clayton noted that the Commission will consider final amendments to the smaller reporting company definition and the thresholds that trigger Sarbanes-Oxley Section 404(b) auditor attestation requirements.  He mentioned that the Commission also will focus on the possible expansion of testing the waters to companies other than emerging growth companies, the disclosure effectiveness initiative, modernization of various Industry Guides, and amendments to the financial information requirements for guarantors and acquired businesses.  Chair Clayton also discussed the rulemaking required of the Commission to amend Rule 701 and Regulation A.  He commented on the success of Regulation A and generally solicited offerings made under Rule 506(c) and noted that the Division of Corporation Finance is considering ways to harmonize and streamline the exempt offering rules in order to enhance their clarity and ease of use.

Chair Clayton also addressed the rulemaking mandates contained in the Small Business Credit Availability Act relating to the securities registration and communication requirements for BDCs and in the Economic Growth, Regulatory Relief, and Consumer Protection Act relating to the securities registration and communication requirements for closed-end funds.  Finally, he noted the Commission’s remaining Dodd-Frank Act rulemaking mandates relating to executive compensation rules and the specialized disclosure rules.  The full text of the prepared testimony may be found here.

Reports that the Securities and Exchange Commission was considering allowing companies that were undertaking IPOs to include mandatory arbitration provisions in their charters raised many concerns.  While the inclusion of such provisions does not appear to be a priority for the Commission, the consideration has resulted in a series of letters between members of Congress and the Commission that are worth reading.  The communications may not be as interesting as the Issa-Schapiro letters, but certainly present a good history lesson regarding the matter.  In a March 12, 2018 letter to Chair Clayton, Congresswoman Carolyn Maloney and others outline the historic views of the Commission that forced arbitration of securities law claims is contrary to public policy and contrary to the Supreme Court’s view that such a provision would violate the anti-waiver provisions of Section 29(a) of the Securities Exchange Act.  In a letter dated April 24, 2018, Chair Clayton responded to Representative Maloney and her Congressional colleagues.  Chair Clayton’s letter includes a summary prepared by the Division of Corporation Finance regarding how it has addressed mandatory arbitration provisions to date.  The summary notes that this issue arose in 2012 in the context of the Division’s review of an IPO filing wherein the company’s charter documents contained a mandatory arbitration provision.  The Division was at the time unable to conclude that such a provision was consistent with the public interest and protection of investors and, therefore, the Division could not declare effective the registration statement if that provision was included in the charter documents.  The Commission would have had to make a decision on the request for acceleration of the effectiveness of the registration statement.  The Commission staff has noted that certain issuers conducting Regulation A offerings have included mandatory arbitration provisions in their charter documents; however, the Staff concluded that it did not have grounds to withhold qualification of the Regulation A offerings.  Similarly, foreign companies with securities listed on U.S. securities exchanges have included mandatory arbitration provisions due to local law requirements.  The summary concludes with the note that the Division would defer the acceleration of effectiveness of an IPO registration statement where the issuer’s charter documents include a mandatory arbitration provision and refer the matter to the Commission.  On May 3, 2018, Senator Sherrod Brown and other members of the Senate wrote a letter to Chair Clayton noting their encouragement of the skepticism Chair Clayton expressed during his Congressional testimony regarding mandatory arbitration clauses but urged the Chair to clarify the Commission’s position and declare that it intends to maintain its view against mandatory arbitration.

In his article, author Merritt B. Fox considers the appropriate disclosure requirements in the context of public offerings, such as offerings made in reliance on Rule 506(c), Regulation A, and Regulation CF, undertaken by privately held companies as to which there is little or no previously available information, resulting in information asymmetries. He begins his analysis by going back to first principles.  Information asymmetries may motivate potential investors to exact a significant discount from the issuer in connection with a financing.  The asymmetries can be addressed in a variety of ways, including reliance on intermediation by a gatekeeper like an underwriter.  Another, of course, is requiring disclosures to be made in connection with the proposed offering and/or following the completion of the offering.  Imposing issuer liability and underwriter liability would accompany the mandatory disclosure framework in order to compel issuers and gatekeepers to undertake their disclosure obligations seriously.  Having established these principles, Fox considers the current framework for each of the three offering exemptions.  In a Rule 506(c) offering, there is no required disclosure, and no ongoing disclosure obligation following completion of the offering.  An issuer is subject only to liability under Rule 10b-5 for material misstatements made in connection with the offering.  There is no underwriter taking principal risk that would function in the role of a gatekeeper.  There is no identified approach to addressing information asymmetries in Rule 506(c) offerings.  In Regulation A offerings, there is a mandatory disclosure requirement at the time of the offering and a periodic disclosure requirement following completion of the offering.  The issuer is subject to liability subject to a due diligence defense.  An underwriter participating in a Regulation A offering also is subject to liability. Regulation CF also requires that certain information be disclosed at the time of the offering, and in certain instances requires ongoing disclosures post offering.  The issuer also faces strict liability subject to a due diligence defense.  There is no “firm commitment” underwriter in a crowdfunded offering.  The article asks whether the reduced disclosure requirements are sensible when one considers the burdens that may be placed on smaller issuers, on the one hand, and the information asymmetries and possibility of adverse selection that are associated with the offering of new securities into the market.

Congress has passed the Economic Growth, Regulatory Relief, and Consumer Protection Act, which principally addresses financial regulatory measures.  The legislation also includes a number of securities law related provisions.  For example, Section 503 requires that the SEC review the findings and recommendations of the annual SEC Government-Business Forum on capital formation and address the findings and recommendations publicly.  Section 504 expands the Section 3(c)(1) exception under the Investment Company Act to include venture capital funds that have up to 250 investors and $10 million in aggregate committed capital contributions and uncalled capital.  Section 507 raises the Section 701 threshold to $10 million and indexes the threshold to inflation going forward.  Section 508 allows reporting companies to rely on Regulation A.  Rule 509  provides closed-end funds listed on a national securities exchange and certain interval funds to benefit from the same securities offering and other provisions available to operating companies.  After the Small Business Credit Availability Act was passed modernizing the securities offering and communications related provisions for BDCs, there had been concern that closed-end funds had been forgotten.

See the firm’s Legal Update here.

 

In recent remarks, Commissioner Peirce commented on capital formation, repeating some statistics about the decline in the number of IPOs in recent years and the relatively small number of public companies (about 4,500).  She noted that many companies are able to raise capital in private placements or exempt offerings; however, fewer investors are able to share in the growth of such companies that stay private.  She noted a few regulatory impediments that may make becoming a public company less compelling.  Among these impediments, Commissioner Peirce included the Sarbanes-Oxley Section 404(b) attestation requirement and the burden it places, especially on pre-revenue companies, Dodd-Frank Act-mandated disclosure requirements, such as those on conflict minerals, Dodd-Frank Act executive compensation requirements like the pay ratio rule, and the lack of regulation of proxy advisory firms.  The Commissioner also commented on Regulation A, noting that as of the end of 2017, 185 Regulation A offerings had raised approximately $670 million in offering proceeds, and noting that the current offering threshold for Regulation A offerings may still be too low to be a meaningful stepping stone to an IPO.  The Commissioner also raised a suggestion that has been raised by Commissioner Piwowar from time to time; that is, abandoning the accredited investor standard and allowing all investors to participate in exempt offerings.  The full text of the remarks are available here.

Today, Bill Hinman, Director of the Commission’s Division of Corporation Finance testified to the House Financial Services Subcommmittee.  Mr. Hinman provided an overview of the Division’s ongoing projects and its priorities.  He noted that the Commission remains focused on capital formation related initiatives designed to promote interest in having more companies undertake IPOs.   In this regard, for the first time, he mentioned that the Division is considering rules extending the ability to test-the-waters to non-emerging growth companies.  Extending the test-the-waters provisions to non-EGCs has been a measure that has been included in various proposed bills that have garnered strong bipartisan support on the House side.

Mr. Hinman also reported on measures affecting smaller companies. Mr. Hinman provided market updates on Regulation A offerings (since the amendments in 2015, 78 issuers have raised approximately $670 million in 185 offerings) and Rule 506(c) (noting $147 billion has been raised in reliance on generally solicited offerings under Rule 506).  Mr. Hinman indicated that the Staff would be conducting retrospective reviews of these new exemptions.  Mr. Hinman noted that the Division is considering recommendations that would expand the accredited investor definition.  This is interesting given that amendments to the definition had not appeared as a high priority in the Commission’s regulatory agenda.  He also signaled that the Division is considering harmonizing or rationalizing the exempt offering rules, which had been suggested by practitioners for some time now.

Addressing upcoming priorities, Mr. Hinman again mentioned the proposed changes to the smaller reporting company definition, the disclosure effectiveness initiative, the resource extraction payments rule, and possible revisions to the conflict minerals rule.  The written testimony is available here.

Chair Clayton focused his testimony on the Commission’s plans with respect to the fiscal year 2019 budget requests, and provided some commentary regarding the best interests rule proposal.  The written testimony is available here.